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BATS Exchange Open Letter: Calling for Lower Access Fees, More Disclosure

In early January, BATS Global Markets, Inc. (“BATS”), the third largest U.S. equity market operating four equities exchanges, suggested significant changes to the U.S. market structure in an open letter to the U.S. securities industry (“the industry”). BATS also indicated that it would petition the Securities and Exchange Commission (“SEC”) to implement its proposed changes. 

BATS suggested open and constructive dialog about potential market structure between industry and the SEC as a key factor in improving the U.S. equity market for all investors, while still providing for appropriate competition among markets and market participants. BATS also noted the growing concern within the industry regarding the amount of trading done away from the displayed exchanges and the incentives brokers received for routing orders to one destination over another.  

Some market professionals have advocated for a “grand compromise” that would impose dramatic regulatory change in the form of a trade-at prohibition. This would force order flow to the exchanges in order to decrease access fees and ban exchange rebates for market participants. BATS believes this compromise would ultimately be harmful and more expensive to end investors. As the letter states:

BATS believes that a “grand compromise” between industry professionals would ultimately be harmful to end investors. While exchanges, including BATS, would stand to benefit from increased volume directed to them, and brokers would benefit from a reduction in exchange fees, investors will likely pay more both in the form of potentially wider spreads as well as fewer and inferior execution choices resulting from restrictions on competition.

As an alternative, BATS advocated for regulatory changes in the following areas: Access Fees, Order Handling Transparency, Small Trading Centers, and a revision to Regulation NMS. 

BATS favors a reduction in the access fee currently imposed in Regulation NMS. The Exchange proposed a reduction of close to 80% for certain liquid securities. BATS recommended that any liquidity rebate be less for highly liquid securities. It is proposed an access fee reduction for the most liquid securities from 30 cents per 100 shares ($0.0030) down to 5 cents per 100 shares ($0.0005). For less liquid securities, access fee caps would be tiered based on a security’s characteristics. BATS argued that this approach would preserve the benefits of the current market structure while providing more opportunities to improve the trading experience for illiquid securities. Additionally, the access fee reduction in the most liquid securities would reduce incentives to route away from the exchanges. 

To better inform investors with respect to their brokers’ order handling decisions, BATS proposed that all Alternative Trading Systems (“ATSs”) should be required to provide customers with their rules of operation. This disclosure would include full descriptions of order types, pricing tiers, all forms of order-routing logic, and transparent participant eligibility guidelines. Using this information, institutional investors could better determine if a venue and/or order routing product met their trading needs. These transparency initiatives, in combination with the access fee reductions discussed above, provided a more “elegant” solution to bringing volume back to the exchanges than the “grand compromise.”

According to BATS, all exchanges and ATSs, regardless of their size, have a significant competitive advantage by virtue of the “trade through rule.” The trade through rule, under Regulation NMS, requires all market participants to do business with all execution venues that display orders to the market. BATS argues that while in some cases the marginal operating cost for a “new” exchange is near zero, market participants may incur substantial costs when trying to connect to these small venues. To combat this problem, BATS proposed a revision to Regulation NMS that provided until an exchange or other currently-protected market center achieved greater than 1% share of consolidated average daily trading volume in any rolling three-month period: (1) it should no longer be protected under the trade through rule; and (2) it should not share in/receive any NMS plan market data revenue. 

The result of implementing these provisions would serve two purposes. First, client costs in connecting to small exchanges and ATSs would potentially be reduced. This would give the small exchanges and ATSs flexibility to route around them if they chose to and also continue to protect displayed limit orders for the larger venues. Second, market data revenue that may be the basis for the continued operation of marginal venues would be taken away. 

The ultimate goal of BATS’ letter is to generate feedback from the industry as well as garner support of its proposals before sending a petition of the proposed changes to the SEC.  

The primary materials for this post are available on the DU Corporate Governance Website.

December comment letter:

Jan. 6: 

Rulemaking petition:


Court Declines to Dismiss Allegations of Material Misstatements and Omissions Surrounding Company’s IPO

In In re Fairway Group Holding Corp. Securities Litigation, 2015 BL 12688 (S.D.N.Y. Jan. 20, 2015), the District Court for the Southern District of New York granted in part and denied in part the motions to dismiss the complaint brought by Jacksonville Police and Fire Pension’s (“Plaintiff”) against Fairway Group Holding Corp. (“Fairway”), Sterling Investment Partners, et al. (“Sterling”), certain directors and officers of Fairway, and the syndicate of underwriters involved with Fairway’s initial public offering (collectively, the “Defendants”) alleging securities fraud.   The complaint specifically alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 in connection with Fairway’s initial public offering (“IPO”).

According to the allegations in the complaint, Defendants in the period preceding the IPO made certain representations about Fairway’s business in the grocery store industry, specifically regarding new store growth, same store sales growth, and deferred tax assets reported in the financial statements. Plaintiff alleged that the statements were misleading and that it relied upon the statements in purchasing stock after the IPO.   

Plaintiffs alleged that Fairway’s statements about its “proven ability to replicate its store model” and its “scalable infrastructure” indicated Fairway’s ability to continue its new store growth strategy, which failed to be true. Plaintiffs further alleged that statements about the “disruption” to sales caused by Hurricane Sandy omitted that in actuality, sales were boosted by the storm. Lastly, Fairway stated beliefs about future taxable income that were alleged to be false.  Defendants argued Plaintiff did not adequately plead a material misstatement or omission, scienter, or loss causation.

A prima facie claim under Rule 10b-5 requires allegations of “(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.” The Private Securities Litigation Reform Act (“PLSRA”) requires a securities fraud complaint to specify each statement alleged to have been misleading, the reasons such statements were misleading, and include the information on which such belief was formed.

Scienter refers to the required state of mind. The PLSRA requires the complaint to allege facts giving rise to a strong inference of scienter.  Plaintiff can meet the pleading standard by showing that the Defendant had the motive and opportunity to commit the alleged act or by showing  “circumstantial evidence of conscious misbehavior or recklessness.”

The court found that the IPO constituted a sufficient motive to commit fraud. Id. (“Plaintiff alleges that in misrepresenting and concealing the state of Fairway's business, defendants were able to raise millions of dollars in the offering, nearly recouping their entire $150 million investment in Fairway, "that they otherwise would not have been able to if they presented a more complete and accurate financial snapshot." ).  Further, because Defendants were officers and directors of the company with access to all the key company information, the court inferred they had ample opportunity to commit fraud.   

Additionally, the court found loss causation was inferred due to the drop in share prices following Plaintiff’s purchases of Fairway stock and the Defendants’ correction to their previous false statements. Plaintiff, therefore, adequately alleged violations of Rule 10b-5.

Section 20(a) liability arises where the defendant controls the person who commits a fraudulent act and is therefore responsible “in some meaningful sense.” Plaintiff’s claim under this section survived as to all Defendants except for Sterling Advisors, a member of Sterling Investment Partners. While the other Defendants met the elements of Section 20(a), the court found Sterling Advisors only gave advice and did not reach the needed level of control.

Finally, Sections 11 and 12 apply to omissions and misstatements of material fact in a registration statement or in a prospectus, and Section 15 assigns liability to those persons with control over anyone liable under Sections 11 or 12. The court found Plaintiff sufficiently alleged omissions and misstatements required by Section 11. It also found, however, that Section 12(a)(2) did not apply because Plaintiff did not allege that shares were acquired in the IPO. 

Ultimately, the court found Plaintiff sufficiently alleged claims under Section 10(b) and 20(a) of the Securities Exchange Act and Rule 10b thereunder, as well as Sections 11 and 15 of the Securities Act. The court also dismissed Plaintiff’s claims as to defendant Sterling Advisors and all claims under Section 12(a)(2) of the Securities Act.

The primary materials for this case may be found on the DU Corporate Governance Website.


The Second Circuit Prevents UBS from Arbitrating $350 Million Claim Against Nasdaq in Facebook IPO

In Nasdaq OMX Group, Inc. v. UBS Securities, LLC, 770 F.3d 1010 (2d. Cir. 2014), the Second Circuit Court of Appeals held defendants could not require Nasdaq OMX Group Inc. and the Nasdaq Stock Market LLC (collectively “Nasdaq”) to arbitrate claims concerning Nasdaq’s alleged mismanagement of the highly anticipated initial public offering (“IPO”) of Facebook, Inc. (“Facebook”).

According to the allegations, Nasdaq, on May 18, 2012, scheduled secondary trading for the Facebook IPO to begin at 11:00 a.m. Eastern Standard time. Technical difficulties with “Cross,” the computerized system that typically launches IPO trading by matching buy and sell orders to determine the opening price, caused a delay in the commencement of trading. As a result, over 30,000 orders entered between 11:11:00 a.m. and 11:30:09 a.m. were not included in the completed IPO Cross. Nasdaq canceled some of these orders and released the others into the market at 1:50 p.m. In addition, Cross failed to transmit certain trade confirmations for orders placed before 11:30:09 a.m. Consequently, Nasdaq members could not determine if their orders processed and what position they held in Facebook securities.

The Securities and Exchange Commission (“SEC”) initiated an investigation and ultimately brought disciplinary charges against Nasdaq. Nasdaq settled the case with the SEC and paid a civil penalty of $10 million. The SEC press release for this case can be found here.

In the aftermath of the Facebook IPO, Nasdaq amended its rules to permit the establishment of a voluntary procedure to compensate Nasdaq members injured in connection with the Facebook IPO. Defendant, UBS Securities, LLC (“UBS”), did not pursue that opportunity for relief and instead initiated an arbitration proceeding against Nasdaq under a separate services agreement for breach of contract, indemnification, breach of implied duties of good faith and fair dealing, and gross negligence and sought over $350 million in damages.

Nasdaq commenced a declaratory judgment action to prevent UBS from pursuing arbitration. On June 28, 2013, the United States District Court for the Southern District of New York ruled in Nasdaq’s favor, and UBS appealed to the Second Circuit. 

UBS contended the district court erred in exercising federal question jurisdiction in a case presenting only state law claims. UBS also contended the district court improperly concluded the court, rather than an arbitrator, should decide whether UBS’s claims were subject to arbitration. Lastly, UBS challenged the district court’s decision that its claims against Nasdaq were not arbitrable.

With respect to federal question jurisdiction, the Second Circuit observed that a court may properly exercise jurisdiction over a “special and small” category of actual state claims that present significant, disputed issues of federal law. Although UBS’s arbitration demand asserted only New York state law claims, the claims necessarily raised actually disputed issues of federal securities law. In addition, the issues presented were of substantial importance to the federal system, as a whole, and, as a result, the exercise of federal jurisdiction in these circumstances would not disrupt any federal-state balance approved by Congress.

In considering the role of the courts in resolving the issue of arbitrability, the Second Circuit relied on the premise that the law generally treated the issue as one for judicial determination “unless the parties clearly and unmistakably provide[d] otherwise.” Nasdaq and UBS were parties to a bilateral service agreement that was silent as to who should decide arbitrability. Accordingly, the Second Circuit held the district court correctly determined that it should resolve the arbitrability of UBS’s claims, rather than commit that question to an arbitrator.

The Second Circuit also affirmed the trial court’s decision that the relevant issues were not subject to arbitration. Both UBS and Nasdaq agreed their agreement to arbitrate was valid; therefore, the only issue on appeal was whether the agreement covered UBS’s claims. The Second Circuit looked to the language of the contract to define the disputes subject to arbitration. The service agreement stated the parties intended to submit all disputes to arbitration “except as provided in the Nasdaq OMX Requirements.” The “Nasdaq OMX Requirements” incorporated Nasdaq rules and rule interpretations. Because Nasdaq Rule 4626(a) forbid claims on losses experienced during trading on the exchange, the Second Circuit held that the parties could not have intended to arbitrate claims precluded by the provision.   

In conclusion, the Second Circuit Court of Appeals upheld the district court’s decision to enjoin UBS from pursuing arbitration against Nasdaq and remanded the case to the district court for further proceedings.

The primary materials for this case may be found on the DU Corporate Governance website. 



On July 21, 2014, the fourth anniversary of the Dodd-Frank Act, Democrats and Republicans on the House Financial Services Committee published separate reports regarding the law. The 30-page report prepared by Democratic members of the Committee remarked that regulators had made “tremendous progress” in implementing the Dodd-Frank Act. The Democratic report, however, claimed the Republican Majority stymied this progress through its concerted efforts to underfund regulators’ operations, pressure regulators relentlessly to weaken regulations, and otherwise erect roadblocks to implementation.  

The Democrats’ report complimented the rules put in place by regulators, including the Securities and Exchange Commission (“SEC”) and Commodity Futures Trading Commission (“CFTC”). The report applauded the Dodd-Frank Act for providing shareholders a non-binding vote to approve or disapprove executive compensation and golden parachutes. It also claimed the SEC has recovered more than $9.3 billion in civil fines and penalties since 2011, due to the increased authority the Dodd-Frank Act provided the SEC.

With respect to whistleblower enhancements in the Dodd-Frank Act, the report noted that the SEC has already received more than 6,573 tips from 68 countries. Additionally, in order to implement the Dodd-Frank Act, “the CFTC has completed 65 final rules, orders, and guidance documents resulting in the registration and enhanced oversight of 102 Swap Dealers, two Major Swap Participants, 22 Swap Execution Facilities, and four Swap Data Repositories.”

Moreover, the Dodd-Frank Act created the Consumer Financial Protection Bureau (CFPB) to ensure American consumers “get the clear, accurate information they need to shop for mortgages, credit cards, and other financial products, and protects them from hidden fees, abusive terms, and deceptive practices through strong enforcement of consumer protection laws.” The report credited the CFPB with returning $4.6 billion to 15 million consumers subjected to unfair and deceptive practices. The report praised the CFPB for creating a qualified mortgage rule that established a federal standard for all home loans to ensure borrowers can repay their loans.

Additionally, the qualified mortgage rule prohibited lenders from receiving financial rewards for subprime loans that encouraged lenders to steer borrowers into more expensive loans. This included prohibitions on “yield, spread premiums” that lenders provided brokers to encourage the origination of riskier loans to borrowers, especially minorities, who otherwise qualified for superior loans. The Democrats’ report also praised the implementation of the Volcker Rule that limits financial institutions receiving government assistance, proprietary trading and investment in and sponsorship of hedge funds and private equity funds. Because of the Volcker Rule, “banks have shifted away from speculative trading to investments in the real economy.” 

Despite this progress, the Democratic report accused the Republican Majority of engaging in a campaign to repeal, weaken, or otherwise pressure regulators to significantly modify provisions in almost all of the titles of the Dodd-Frank Act. The report also alleged the Republican Majority underfunded regulators like the SEC and CFTC and subjected their rulemakings to constant implementation hurdles. For example, the report stated the Republican Majority passed bill H.R. 2308 in the 112th Congress and H.R. 1062 in the 113th Congress that would subject SEC rulemakings to stricter cost-benefit standards. Moreover, the report criticized the bills for not providing further funding to the SEC, even though the bills would require significantly more resources for economic analysis before the SEC could issue rulemakings. In addition, the report stated the Republican Majority refused to adequately increase the funding of the SEC and CFTC despite the fact their responsibilities increased under the Dodd-Frank Act. The report cautioned, “[i]f enacted, the cumulative effect of these efforts would render the Dodd-Frank Wall Street Reform and Consumer Protection Act essentially toothless, inviting a return to the opacity, risk, and deregulation that caused the 2008 crisis.” 

The Democratic report concluded that since the Dodd-Frank Act’s passage, increased stability in the market has led to economic growth. The report indicated that the private sector created almost 9.7 million payroll jobs since February 2010. In addition, unemployment is now at 6.1 percent, its lowest level since September 2008. Moreover, real GDP growth now stands 5.5 percent higher than its pre-recession high in late 2007. Nevertheless, the Democrats’ report called the Republican Majority a roadblock in regulators’ Dodd-Frank Act implementation progress.  

The primary materials for this case may be found on the DU Corporate Governance website. 


The Curious Case of Etsy

Etsy has just gone public.  Prices on the first day doubled.  The DealBook wrote a story suggesting that Etsy was only the second (and by far the largest) B Corporation to go public.  See Etsy I.P.O. Tests Pledge to Balance Social Mission and Profit.  As the article noted: 

  • Etsy is one of a growing number of companies, called B Corps, that pledge to adhere to social and environmental accountability guidelines set by a nonprofit organization called B Lab. And Etsy on Thursday became only the second for-profit company to go public out of more than 1,000 companies that have that certification.

Etsy is a B Corporation, having been certified as such (Etsy was certified in 2012).  But as the article pointed out, Etsy is in fact not incorporated under the benefit corporation statute in the state of incorporation (in this case, Delaware).  Id. ("B Lab is giving companies four years from the date any relevant state legislation is passed to comply with the state law or risk losing B Corp certification.").  In fact, Esty is incorporated in Delaware as a traditional corporation.  The articles are here.  The bylaws are here.

As a result, directors have traditional fiduciary duties to shareholders.  They may not, legally, dispense with the obligations to shareholders in order to benefit the community.  The S-1, therefore, was very careful to discuss community obligations as a long term benefit to the corporation.  The Form S-1 is here

As the S-1 stated: 

  • Adherence to our values and our focus on long-term sustainability may negatively influence our short- or medium-term financial performance.  Our values are integral to everything we do, and accordingly, we intend to focus on the long-term sustainability of our business and our ecosystem. We may take actions that we believe will benefit our business and our ecosystem and, therefore, our stockholders over a period of time, even if those actions do not maximize short- or medium-term financial results. However, these longer-term benefits may not materialize within the timeframe we expect or at all. For example: 
  • we may choose to prohibit the sale of items in our marketplace that we believe are inconsistent with our values even though we could benefit financially from the sale of those items;
  • we may choose to revise our policies in ways that we believe will be beneficial to our members and our ecosystem in the long term even though the changes are perceived unfavorably among our existing members;
  • or we may take actions, such as investing in alternative forms of shipping or locating our servers in low-impact data centers, that reduce our environmental footprint even though these actions may be more costly than other alternatives.

So, as currently configured, Etsy has the same fiduciary obligations as other corporations.  In that sense, investors are taking no greater risk than with any other investor in any other corporation, at least with respect to the legal obligations of directors. 

Indeed, Etsy apparently has five years to reincorporate as a B Corporation to maintain its B Corporation status.  The S-1 contained no commitment with respect to that step and, to the exent the board considers the issue, it will have to determine that amending the articles is in fact in the best interests of shareholders (rather than the community). 


Assistant Director of the Center for Transactional Law and Practice (Emory Law School)

Per Dean Bobby Ahdieh:  "Emory is expanding the leadership of its growing Transactional Law Program – previously headed by Tina Stark and Carol Newman, and now led by Sue Payne.  See the announcement below.”

Emory Law School seeks an Assistant Director of the Center for Transactional Law and Practice to teach in and share the administrative duties associated with running the largest program in the Law School.  Each candidate should have a J.D. or comparable law degree and substantial experience as an attorney practicing or teaching transactional law.  Significant contacts in the Atlanta legal community are a plus. 

Initially, the Assistant Director will be responsible for leading the charge to further develop the Deal Skills curriculum.  (In Deal Skills – one of Emory Law’s signature core transactional skills courses – students are introduced to the business and legal issues common to commercial transactions.)  The Assistant Director will co-teach at least one section of Deal Skills each semester, supervise the current Deal Skills adjuncts, and recruit, train, and evaluate the performance of new adjunct professors teaching the other sections of Deal Skills

As the faculty advisor for Emory Law’s Transactional Law Program Negotiation Team, the Assistant Director will identify appropriate competitions, select team members, recruit coaches, and supervise both the drafting and negotiation components of each competition.  The Assistant Director will also serve as the host of the Southeast Regional LawMeets® Competition held at Emory every other year. 

Additionally, the Assistant Director will be responsible for the creation of two to three new capstone courses for the transactional law program.  (A capstone course is a small, hands-on seminar in a specific transactional law topic such as mergers and acquisitions or commercial real estate transactions.)  The Assistant Director will identify specific educational needs, recruit adjunct faculty, assist with curriculum design, and monitor the adjuncts’ performance.   

Besides the specific duties described above, the Assistant Director will assist the Executive Director with the administration of the transactional law program and the Transactional Law and Skills Certificate program.  This will involve publicizing the program to prospective and current students, monitoring the curriculum to assure that students are able to satisfy the requirements of the Certificate, and counselling students regarding their coursework and careers.  The Assistant Director can also expect to participate in strategic planning, marketing, fundraising, alumni outreach, and a wide variety of other leadership tasks. 


Emory University is an equal opportunity employer, committed to diversifying its faculty and staff.  Members of under-represented groups are encouraged to apply.  For more information about the transactional law program and the Transactional Law and Skills Certificate Program, please visit our website at:

To apply, please mail or e-mail a cover letter and resumé to: 

Kevin Moody

Emory University Law School

1301 Clifton Road, N.E.

Atlanta, GA  30322-2770




Khazin v. TD Ameritrade Holding Corporation: Dodd-Frank Whistle-Blower Must Arbitrate Reprisal Claims

In Khazin v. TD Ameritrade Holding Corp., 773 F.3d 488 (3d Cir. 2014), the United States Court of Appeals for the Third Circuit (the “Court of Appeals”) affirmed the district court’s holding, which dismissed Boris Khazin’s (“Khazin”) Dodd-Frank retaliation claim against TD Ameritrade Holding Corp., TD Ameritrade Inc., Amerivest Management Co., and Luke Demmissie (collectively “TD”). In addition, the Court of Appeals affirmed the district court’s holding, which compelled arbitration pursuant to a predispute arbitration agreement between Khazin and TD. The Court of Appeals concluded that Khazin’s claim did not qualify for the statutory exemption from the arbitration agreement with TD.

According to the factual allegations, Khazin worked for TD providing professional financial services and performing due diligence on the company’s outgoing financial products. Khazin signed an agreement with TD, agreeing to arbitrate any dispute related to his employment. After discovering the price of one of TD’s products failed to comply with applicable securities regulations, Khazin suggested a price change to his supervisor, Demmissie. Upon learning that the proposed price change would result in a loss of $1,150,000 in revenue, Demmissie allegedly instructed Khazin to discontinue communication about the pricing violation and informed Khazin that TD would not make the price change. Khazin’s employment was later terminated for a supposed billing inconsistency.

Khazin filed suit in New Jersey state court, alleging violation of both state law and the Dodd-Frank Act. After the court dismissed his claims without prejudice for lack of subject matter jurisdiction, Khazin brought a whistleblower claim under the Securities Exchange Act.  See 15 U.S.C. § 78u-6(h).  TD then filed a motion to dismiss and to compel arbitration in accordance with the arbitration agreement between Khazin and TD.

In its motion, TD argued the anti-arbitration provision in the Dodd-Frank Act, which provided an exemption from predispute arbitration agreements (“Anti-Arbitration Provision”), did not apply to claims brought under 15 U.S.C. § 78u-6(h), and therefore did not shield Khazin from his contractual obligation to arbitrate the dispute. As an alternative, TD argued Dodd-Frank’s Anti-Arbitration Provision did not provide retroactive exemption from an arbitration agreement signed, as in Khazin’s case, prior to the enactment of the Act. 

The district court held the Anti-Arbitration Provision did not invalidate arbitration agreements executed prior to the passage of Dodd-Frank. Consequently, the court granted TD’s motion to dismiss and compelled Khazin to arbitrate.  Khazin appealed, arguing the Anti-Arbitration Provision and the essence of the Dodd-Frank Act rendered his arbitration agreement unenforceable.

SOX created protection for whistleblowers and provided them with a private right of action.  See 18 U.S.C. § 1514A.  Dodd-Frank included provisions that prohibited employer retaliation against whistleblowers.  The Act included a private right of action for violations of the anti-retaliation provision.  See 15 U.S.C. § 78u-6(h).  In addition, the Act provided that “[n]o predispute arbitration agreement shall be valid or enforceable, if the agreement requires arbitration of a dispute arising under this section.” 18 U.S.C. §1514A(e)(2).  

The Court of Appeals held that the anti-arbitration provision applied only to actions under 18 U.S.C. §1514A and not actions under 15 U.S.C. § 78u-6(h).  In doing so, the Court relied on the language of the Anti-Arbitration Provision and the structure of the Act.

First, the Court of Appeals reasoned that the phrase “arising under this section” in 18 U.S.C. §1514A(e)(2) expressly limited the application of the Anti-Arbitration Provision to disputes arising under SOX.  Because Khazin’s claim arose under Dodd-Frank, the court held the Anti-Arbitration Provision was not applicable.  

The Court of Appeals also found the structure of the Dodd-Frank Act particularly relevant, noting that Congress did not add an anti-arbitration provision to the Dodd-Frank cause of action but simultaneously appended anti-arbitration provisions to claims arising under various other sections. Thus, the Court of Appeals determined that Congress deliberately excluded Dodd-Frank claims from anti-arbitration protection, despite Khazin’s argument that the omission was inadvertent. Consequently, the Court of Appeals affirmed, though on different grounds, the district court’s order dismissing Khazin’s claim and compelling arbitration pursuant to his employment agreement. 

The primary materials for this post can be found at the DU Corporate Governance website


SEC v. Epstein: Epstein’s Ill-Gotten Gains

In SEC v. Epstein, No. 2:15-cv-00506-WB (E.D. Pa. Feb. 3, 2015), the Securities and Exchange Commission (the “SEC”) filed a complaint in the United States District Court of Pennsylvania against Joel Epstein (“Epstein”) for gains allegedly acquired through insider trading. Epstein consented to an entry of final judgment for violations of Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”).

The SEC alleged that Epstein learned from his son about the impending merger between Nationwide Mutual Insurance Company (“Nationwide”) and Harleysville Group, Inc. (“Harleysville”) in early September 2011. His son allegedly received the confidential information from his girlfriend, who was a legal assistant for a law firm helping Harleysville with the merger. The complaint described their relationship as one of trust and confidence. Once Epstein acquired this information, the complaint asserted that he told his son, “don’t ever mention this again” and “we never talked.” Complaint ¶ 23 at 4, SEC v. Epstein, No. 2:15-cv-00506-WB (E.D. Pa. Feb. 3, 2015). Epstein also alleged to have informed four other people, who in turn purchased 1,000 shares each.

Epstein acquired 4,000 shares in Harleysville stock. On September 29, 2011, Nationwide announced an intent to “acquire all publicly-traded shares of Harleysville for $60 per share” or approximately $760 million. Harleysville’s stock price rose by 87%. Shortly thereafter, Epstein sold his shares.

Rule 10b-5 under the Exchange Act prohibits anyone from engaging in acts or omissions that result in securities fraud. Epstein consented to an injunction for violations of the provision. The injunction required the payment of disgorgement of $237,014—the total of ill-gotten gains acquired by Epstein and his four tippees’—plus $21,599 prejudgment interest and $237,014 in civil penalties. The SEC’s investigation is ongoing.

The primary materials for this case may be found on the DU Corporate Governance website. 


Fisher v. Tails: Supreme Court of Virginia Denies Appraisal Rights to Minority Shareholders, Holds Delaware Corporate Law Trumps Step Transaction Doctrine

In Fisher v. Tails, Inc., 767 S.E.2d 710 (Va. 2015), the Supreme Court of Virginia held that the minority shareholders of a Virginia corporation which re-incorporated in Delaware prior to selling all of its assets were not entitled to Virginia appraisal rights under the “step transaction doctrine.”

Tails, Inc., formerly a Virginia corporation, consummated a four-step transaction pursuant to a purchase agreement with Buena Suerte Holdings, Inc. in which, during a two day period: (1) Tails, Inc. reincorporated from Virginia to Delaware; (2) Tails, Inc. merged with Tails, LLC, a Delaware entity owned by Tails Holdco, Inc.; (3) Tails, LLC amended and restated its LLC agreement “to remove certain limited liability company provisions”; and (4) Tails Holdco, Inc. sold the entirety of its interest in Tails, LLC to Buena Suerte Holdings, Inc.

Shareholders approved the four step transaction at a special meeting. The minority shareholders (holding 21% of the shares) voted against the relevant proposals. The minority shareholders asserted that they were entitled to appraisal rights because the transaction amounted to an asset sale.

In seeking appraisal rights, shareholders argued for application of the “step transaction” doctrine or the “equitable substance over form” doctrine. Under the step transaction doctrine, multiple steps can be construed to be part of a unitary transaction. The equitable substance over form doctrine allows relief to be granted to parties harmed by legal practices that create unfair results.

The Supreme Court of Virginia assumed without deciding that the doctrine applied. The Court recognized that the step transaction and substance over form doctrines were intended to “prevent transactional formalities from blinding the court to what truly occurred” and “allow a court to look beyond form to the substance of a transaction.” The Court found, however, that the doctrine was designed to prevent the use of equitable principles “to recharacterize actions of defined legal significance.” It could not be used, however, to “second guess” the explicit application of a statutory requirement; the statute under which a transaction is effected will govern that transaction.

Virginia law allows corporations to domesticate in other jurisdictions and provides that the laws of the new jurisdiction govern after that point. Virginia Code § 13.1-722.2. Moreover, domestication is not an event that triggers appraisal rights. As a result, the Court declined to find that the properly conducted domestication of a Virginia corporation should be combined with subsequent transactions for purposes of determining the applicability of appraisal rights. The Court also found that, because the subsequent steps took place in Delaware, shareholders were not entitled to appraisal rights under the laws of that state.

The primary materials for this post can be found on the DU Corporate Governance website.


Merion v. BMC: Share-Tracing Requirements Rejected for Appraisal Petitioners

Merion Capital LP and Merion Capital II LP (together, “Merion”) filed a petition for appraisal of stock in the Court of Chancery of Delaware under Section 262 of the Delaware General Corporation Law after acquiring over seven million shares of BMC Software, Inc. (“BMC”). Merion Capital LP & Merion Capital II LP v. BMC Software, Inc., No. 8900-VCG, 2015 BL 579 (Del. Ch. Jan. 05, 2015). BMC argued § 262 precluded Merion’s standing and moved for summary judgment. The court denied BMC’s motion for summary judgment and found Merion had perfected its appraisal rights in BMC’s common stock.

BMC, a Delaware corporation, entered into an Agreement and Plan of Merger (“Merger Agreement”) with Boxer Parent Company, Inc. and its wholly owned subsidiary Boxer Merger Sub Inc. (together, “Boxer”). Boxer was to acquire BMC for $46.25 per share of common stock. Merion acquired 7,629,100 shares of BMC common stock through a series of broker purchases on the public market after determining that the consideration offered in the BMC/Boxer merger undervalued the company. Merion then sought to issue a demand for appraisal of its BMC common stock.

Under § 262, “only the record holder of shares can make the statutorily required demand for appraisal on the corporation.” Merion’s broker refused to direct the record holder, Cede & Co. (“Cede”), to issue a demand for appraisal. As a result, Merion became the record holder of its shares by having its holdings in BMC stock withdrawn from Cede and registered directly with BMC’s transfer agent. Merion then issued an appraisal demand on BMC prior to the stockholder vote on the proposed Merger Agreement. More than two-thirds of the BMC stockholders voted in favor of the merger. 

Merion filed a Verified Petition for Appraisal of Stock to perfect its right to have its shares of BMC common stock appraised by the court. BMC then moved for summary judgment and argued § 262 required proof that each share Merion sought to have appraised was not voted by any previous owner in favor of the merger.

Interpreting the statute according to its plain language, the court determined the petitioner “need only show that the record holder of the stock for which appraisal is sought” held the shares on the date it made a demand for appraisal; continuously held the shares through the effective date of the merger; delivered a timely written demand for appraisal to the corporation before a stockholder meeting to vote on the merger was held; and has not voted in favor of the merger. The court refused to impose share-tracing requirements rejecting BMC’s argument that the legislative purpose favored the imposition of the requirement. Additionally, the court found the statute was “meant to enhance, not limit, rights to appraisal.”

With no dispute as to the material facts of the case the court found Merion, as a matter of law, satisfied all of the standing requirements set forth in § 262. Therefore, the court denied BMC’s motion for summary judgment and held Merion perfected its right to have its shares of BMC stock appraised by the court.

Primary materials for this case may be found on the DU Corporate Governance website.


Special Projects Segment: Opposition to Adopting Crowdfunding Rules

We are discussing possible rulemaking for equity crowdfunding under the JOBS Act.

On October 23, 2013, the U.S. Securities and Exchange Commission (“SEC”) proposed the Crowdfunding Rules (the “Proposed Rules”), which were drafted in connection with Title III of the Jumpstart Our Business Startups Act of 2012 (“JOBS Act”). Title III allows private equity crowdfunding involving non-accredited investors. The SEC intends to protect investors against fraudulent offerings while facilitating capital raising under the Proposed Rules.

While many commenters support at least some aspects of the Proposed Rules, a number of corporations, crowdfunding organizations, law firms, legislators, and academics are concerned that the Proposed Rules will be ineffective in providing the investor protections intended by Congress. Ernst & Young, LLP expressed concern in its comment letter that the Proposed Rules will not benefit small businesses because a company could only crowdfund a maximum aggregate amount of $1 million in a 12-month period, which is arbitrary and unnecessarily low, limiting rather than facilitating capital raising.

EarlyShares, a smaller crowdfunding platform, echoed the concern raised by Ernst & Young and further expressed in its comment letter the need for significant modifications to the Proposed Rules in order to make them more transparent and beneficial to all participants. EarlyShares stated the expense and time required for an issuer to comply with the financial disclosures and ongoing reporting requirements “should be reduced and proportionate with the capabilities of the issuers.” EarlyShares suggested that the cost and burden of disclosure and reporting be balanced against an issuer's interest in protecting sensitive and proprietary data. Without balancing the costs and burdens, EarlyShares forewarned the Proposed Rules may deter companies from engaging in crowdfunding campaigns.

CrowdCheck, Inc., a disclosure and due diligence service provider for early-stage companies, submitted its comment letter seeking clarity as to the specific disclosure requirements. CrowdCheck also requested that “free writing” disclosures be permitted. In support of its immediate online disclosure recommendation, CrowdCheck relied mostly upon the substantial costs and burdens that small businesses would face in order to create a “text-heavy, private placement memorandum” for the offering. CrowdCheck further relied upon the fact that frequent disclosures may be required in response to the “wisdom of the crowd.” Because material disclosures may be frequent, costly, and likely in a file format that is incompatible with EDGAR, CrowdCheck urged the Commission to consider free writing disclosures.

These comment letters highlight how the Proposed Rules do not fulfill the congressional intent to help small businesses raise capital, a sentiment that is reiterated by many commenters. Crowdfunding is popular, in part, because of the low barriers to entry. Under the Proposed Rules, however, many commenters fear that issuers will face significant upfront costs, mandatory information disclosures, and numerous barriers to raising capital. If the costs and burden are not balanced with small business interests, then the possibility of a failed offering increases, leaving the organization in a worse position. It is also possible that extraordinary costs will prevent offerings from happening at all. If safeguards are not embedded to better protect all participants from associated high costs and financial risks, many organizations and individuals may be deterred from utilizing this form of equity crowdfunding. 


Securities and Exchange Commission v. Braverman Update

This post is a continuation of a series of posts tracking SEC v. Braverman, 14CV7482–RMB, (S.D.N.Y.).

On September 16, 2014, the United States District Court for the Southern District of New York entered an order temporarily freezing Dimitry Braverman and Vitaly Pupynin’s assets (the “Order”) in connection to a suit brought by the Securities and Exchange Commission (“SEC”).   The SEC alleged Braverman and Pupynin committed fraud and violated the securities laws.

The United States Attorney’s Office for the Southern District of New York also brought criminal charges against Braverman for alleged insider trading. On November 13, 2014, Braverman pleaded guilty to one count of securities fraud in the criminal case. Braverman’s sentencing is scheduled for March 6, 2015, but his counsel sought an extension for May 2015. The Government has stipulated to the extension, and both parties await the courts ruling in the criminal case. 

On November 19, Braverman and the SEC submitted a third Stipulation and Proposed Order to the court to request new briefing dates in connection with the Order. The parties made this request for an adjournment because of discussions between Braverman and the SEC about potential resolution of the SEC charges. The court entered the Stipulation and Proposed Order extending the parties time to respond to the Order due to the potential for a resolution to narrow or eliminate future litigation related to the asset freeze. The Order remains in effect pending a hearing on the SEC’s Application for the asset freeze. The next hearing is set for February 19, 2015.

The primary materials for this case may be found on the DU Corporate Governance website.



Doshi v. Gen. Cable Corp.: Creating an Inference of Scienter Requires Particularized Facts in Failure to Discover Complex Theft Scheme

In Doshi v. Gen. Cable Corp., No. 2:14-cv-22 (WOB-CJS), 2015 BL 19141 (E.D. Ky. Jan. 27, 2015), the United States District Court for the Eastern District of Kentucky held that City of Livonia Employees’ Retirement System and others similarly situated (“Plaintiffs”) failed to state a claim for failing to allege a strong inference of scienter.

According to the allegations in the complaint, Plaintiffs bought stock in General Cable Corporation over a three-year period. During the period, an inventory theft scheme occurred in an international subsidiary.  General Cable eventually issued two restatements in order to correct the accounting errors resulting from the scheme. Following the corrections, General Cable’s stock price declined. Plaintiffs filed suit, alleging General Cable’s senior executives (“Defendants”) “knew or recklessly disregarded that adverse facts had not been disclosed.” 

To prevail on a claim under Section 10(b) of the Exchange Act or Rule 10b-5 thereunder, a plaintiff must prove that the misstatement or omission was made with scienter. Scienter is a mental state that entails an “intent to deceive, manipulate, or defraud.” An inference of recklessness can arise from “multiple, obvious red flags.” Federal Rule of Civil Procedure 9(b) requires a fraud allegation to be stated with particularity, and the Private Securities Litigation Reform Act (“PSLRA”) requires a plaintiff to “state with particularity facts giving rise to a strong inference” the defendant acted with scienter. The inference of scienter must be as compelling as any other opposing inference drawn from the same set of facts. 

The existence of restatements can create an inference of scienter. Those restatements, however, must demonstrate clear accounting errors that are “‘drastic,’ ‘pervasive,’ and ‘egregious.’” The mere existence of a restatement, without any further evidence, does not create an inference of the necessary intent. Where the fraud occurs in a subsidiary, “courts should not ‘presume recklessness or intentional misconduct from a parent corporation's reliance on its subsidiary's internal controls.’” Corporate scienter can be imputed from “lower-level employees” who contribute to the misstatement but the complaint must nonetheless allege adequate facts “that give rise to a strong inference of fraudulent intent” by those individuals.     

In this case, the complaint failed to allege any particularized facts that would create an inference of scienter. Among other things, the magnitude of the restatements did not constitute sufficient evidence of scienter. The financial impact of the corrections involved only 0.3% of the company’s sales.

In discounting the duration of the errors as evidence of the necessary intent, the court reasoned that “the duration of the errors speaks less to Defendants' states of mind and more to the thieves' sophistication.” The court also found insufficient to establish scienter the allegations that Defendants had access to information that would allow for discovery of the scheme; Defendants had to make multiple restatements; and Defendants’ internal controls were insufficient. Plaintiffs did not “specify any instance where Defendants gained relevant knowledge . . . and disregarded it.”

Nor was the reliance by the parent on the financial and internal control systems of the subsidiary sufficient to show scienter.   The court stated “that courts should not ‘presume recklessness or intentional misconduct from a parent corporation’s reliance on its subsidiary’s internal controls.’” Furthermore, a mistake that is evident in hindsight does not provide evidence of scienter. It is also common for a parent company not to manage a seemingly successful subsidiary. Lastly, Plaintiffs did not allege any facts related to the purpose of concealing fraud.

The United States District Court for the Eastern District of Kentucky held Plaintiffs’ complaint failed to support a strong inference of scienter. Accordingly, the court granted General Cable’s motion to dismiss, dismissing Plaintiffs’ claims with prejudice.

The primary materials for this post can be found on the DU Corporate Governance website.


Dailey v. Medlock Securities Fraud Complaint Dismissed by Sixth Circuit 

In Dailey v. Medlock, 551 Fed.Appx. 841 (6th Cir. 2014), the Sixth Circuit Court of Appeals held the plaintiffs’ complaint failed to state an actionable federal securities fraud claim under F.R.C.P. 9(b) or the heightened pleading standards of the Private Securities Litigation Reform Act (PSLRA). 

According to the complaint, Community Central Bank Corporation solicited investors to purchase private stock in Community Central Bank (CCB) through a Private Placement Memorandum (PPM) dated July 2009. On October 19, 2009 and December 16, 2009, Community Central Bank Corporation issued supplements increasing the offering to $5 million and extending the purchase period.

Plaintiffs, a group of twenty-one investors, purchased CCB stock on December 31, 2009 and January 29, 2010. Shortly thereafter, on March 29, 2010, the Michigan Office of Financial and Insurance Regulation (OFIR) issued a report finding CCB violated laws, rules, and regulations.  Two days later, CCB reported $10 million in fourth quarter losses for 2009. Much of the operating loss came from a valuation allowance on CCB’s net deferred tax assets. CCB described the valuation allowance as a “one time non-cash charge to federal income tax expense.”

Near the end of 2010, CCB entered into a Consent Order with the FDIC and OFIR. Under the Order, CCB agreed to amend its business practices without admitting or denying any violations of law, rule, or regulation. In April 2011, CCB failed and went into receivership. In February of 2012, the plaintiffs filed their complaint against 13 individual CCB officers and directors alleging violations of the federal securities laws.    

To establish a violation under §10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, a plaintiff must allege that a defendant made a material misrepresentation or omission with scienter and the plaintiff’s reliance on the material misrepresentation or omission resulted in the plaintiff’s economic loss.  An omission is actionable if necessary to ensure that a statement made by the company does not mislead the market.

F.R.C.P. 9(b) requires a plaintiff to plead claims brought under §10(b) sounding in fraud with heightened particularity. In addition, the PSLRA requires a plaintiff to plead with particularity facts giving rise to the belief the statements made were misleading and facts giving rise to a strong inference the defendant acted with scienter. 

A plaintiff pleading scienter must provide facts demonstrating a strong inference the defendant acted with the intent to deceive, manipulate, or defraud the plaintiff. A plaintiff adequately pleads scienter under the PSLRA if a reasonable person would consider the inference of scienter as convincing as any other plausible opposing inference. A misstatement or omission is material if a reasonable investor would view the omitted fact as significantly altering the total mix of information made available.

The plaintiffs alleged three categories of misstatements or omissions made by the defendants violated Rule 10b-5. First, the plaintiffs argued that a statement in the PPM indicated CCB maintained adequate levels of capital throughout 2009. Plaintiffs alleged this implication was misleading because the defendants knew CCB would take the valuation allowance at the end of 2009 and the defendants failed to disclose the information in the PPM or its supplements. 

The Sixth Circuit held that the plaintiffs failed to plead any highly particularized facts to support their assertion that the defendants knew about the valuation allowance when they issued the PPM and its supplements. The court further noted that one-month before the plaintiffs purchased the stock, CCB filed a Form 10-Q with the SEC for the third quarter indicating CCB would not take a valuation allowance for that quarter. The 10-Q also stated that a valuation allowance might be necessary in the future, which could adversely affect CCB’s financial position. The court rejected the plaintiffs’ claim that the valuation allowance itself was evidence of the defendants’ prior knowledge. Consequently, the Sixth Circuit concluded that the plaintiffs’ allegations regarding the defendants’ prior knowledge of the valuation allowance failed to state a securities fraud claim under Rule 10b-5. 

Second, the plaintiffs alleged CCB misled investors by describing CCB as “well capitalized” in the PPM and three SEC filings between May and November of 2009. The plaintiffs alleged using this term misled investors because the defendants failed to disclose that CCB was engaged in risky business practices that were later investigated by the OFIR. The court noted that the term “well capitalized” is a term of art under federal banking regulations and did not relate to a general assessment of CCB’s business practices. The plaintiffs did not argue that CCB failed to meet the definition of “well capitalized” under the applicable regulatory criteria. The Sixth Circuit emphasized that the PPM stated CCB was “well capitalized” pursuant to “applicable regulatory capital guidelines.” The PPM further stated that the purpose of the stock offering was to improve CCB’s capital levels in light of a poor economic forecast. In addition, the PPM included a twenty-three page detailed discussion of the risks related to CCB’s business. Lastly, the court noted that CCB accurately reported itself as “adequately capitalized” in its Fourth Quarter filings of 2009 when CCB’s status changed. Therefore, the Sixth Circuit concluded the plaintiffs’ allegation that the defendants misled investors by describing CCB as “well capitalized” failed to state a claim under Rule 10b-5.    

Finally, the plaintiffs argued that the PPM’s statement that CCB’s operations were subject to extensive regulation by federal, state, and local governments was misleading because the defendants did not disclose they were violating laws and regulations and were under investigation by the OFIR. The plaintiffs did not plead with particularity what law or regulation the defendants violated. The Sixth Circuit noted the statement was factually accurate.  The PPM did not represent that CCB believed it was compliant with the law.  Under Sixth Circuit precedent, a nonspecific claim of legal compliance did not constitute an actionable claim for misrepresentation under Rule 10b-5 and did not require disclosure of purported illegal activity by a company. Accordingly, the Sixth Circuit held the plaintiffs failed to adequately plead an actionable Rule 10b-5 claim.

The Sixth Circuit went on to dismiss plaintiffs’ claim under §20(a) of the Exchange Act for control person liability, because the plaintiffs failed to state the requisite underlying claim for securities fraud under Rule 10b-5.  

In conclusion, the Sixth Circuit Court of Appeals upheld the district court’s decision to dismiss the plaintiffs' federal securities fraud claims.  

The primary materials for this case may be found on the DU Corporate Governance website. 


In re Nine Systems: Court Finds Breach of Fiduciary Duty Despite Fair Price 

In In re Nine Systems Corporation Shareholders Litigation, Consol. C.A. No. 3940-VCN., 2014 BL 245208 (Del. Ch. Sept. 4, 2014), the Court of Chancery of Delaware considered a challenge to a recapitalization brought against, among others, a controlling group of shareholders and four directors of Nine Systems (collectively “Defendants”). The court determined Defendants breached their fiduciary duties by engaging in a recapitalization that was not entirely fair due to the “grossly inadequate process.” The court, however, found Plaintiffs received a “fair price” and were therefore not entitled to monetary damages. Nonetheless, the court granted leave to submit a petition for attorneys’ fees and costs.

Plaintiffs’ claims turned on the 2002 recapitalization (the “Recapitalization”) of a start-up company—Streaming Media Corporation, later known as Nine Systems Corporation (the “Company”). During the Recapitalization, the controlling shareholders increased their equity through the acquisition of convertible preferred shares, resulting in the dilution of Plaintiffs’ ownership percentage from 26% to 2%. In November 2006, Akamai Technologies, Inc. (“Akamai”) purchased the Company for approximately $175 million. Plaintiffs argued the Recapitalization was unfair and sought over $130 million in damages.

In order for Plaintiffs to have standing to challenge the recapitalization as a direct claim, they needed to establish the presence of a control group—the functional equivalent of a controlling shareholder. Collectively, a group of shareholders may be considered a controlling shareholder.  Plaintiffs had the burden of showing the group of shareholders were connected in a significant way and were working together towards a mutual goal. The court found that the circumstances surrounding a “right to invest” provided to an investor prior to the recapitalization demonstrated the presence of a control group.  The court stated: “Particularly in light of Catalyst’s earlier comments in the Catalyst Memo, this conduct here demonstrates an agreement, arrangement, and legally significant relationship among Wren, Javva, and Catalyst—who together owned a majority of the Company’s stock—to accomplish the Recapitalization. Thus, as controlling shareholders, they owed fiduciary duties to the other shareholders in the Company.

As an alternative ground, the court examined whether Plaintiffs had standing to challenge the Recapitalization under the theory that the majority of the directors were impermissibly conflicted. The court acknowledged that, “while reasonable minds disagree,” plaintiffs could also “establish standing by proving that a majority of the Board was conflicted—here, meaning interested or not independent—when it approved and implemented the Recapitalization.” Analysis of independence must occur on a director-by-director basis. Plaintiffs established that four of the directors had a fiduciary relationship with their respective entities and therefore faced a potential conflict of interests in any given transaction with the Company. The court found that it was “undisputed” that two of the directors had an incentive “to maximize the value of their investment, while the stockholders who did not participate in the Recapitalization—including the Plaintiffs—would seek to act in the best interests of the Company.” The court determined a third director also faced a “dual fiduciary problem” although not as readily apparent as the others. As a result, the Plaintiffs had “direct standing to challenge the Board’s conduct in the Recapitalization.”  

In examining the recapitalization, the court found an absence of “fair process.” Dwyer, the majority owner of one of the shareholders, “alone calculated” the value of the Company. The Board apparently had no significant role in the process.  And “[n]o independent valuation was solicited.” Moreover, the terms of the Recapitalization changed between board approval and implementation, something that “compound[ed] the evidence leading to a conclusion of unfair dealing.” Stockholders were notified of the Recapitalization, but “that document was materially misleading.” 

Although finding unfair dealing, the court nonetheless concluded the price paid in the Recapitalization was fair. Expert testimony showed that the Company’s equity had no value before the Recapitalization. Thus, the court concluded that the Recapitalization approved by a majority of conflicted directors was nonetheless at a fair price.

Although fair, the court determined that the absence of adequate process resulted in a violation of fiduciary duties. In awarding damages, the court concluded that it would be inappropriate to award disgorgement, recessionary, or other monetary damages to Plaintiffs because the “unfair Recapitalization” was effected at a fair price and any damages would be speculative in nature.  The court, however, granted Plaintiffs leave to petition the court for an award of attorneys’ fees and costs.

The primary materials for this case may be found on the DU Corporate Governance website


Abrams v. MiMedx Group., Inc.: Motion to Dismiss Denied by District Court 

In Abrams v. MiMedx Group, Inc., No. 113-CV-3074-TWT, 2014 WL 3952923 (N.D. Ga. Aug. 13, 2014), the district court held plaintiffs’ complaint stated an actionable federal securities fraud claim under F.R.C.P. 9(b) and the heightened pleading standards of the Private Securities Litigation Reform Act (“PSLRA”) of 1995. 

According to the complaint, MiMedx Group, Inc. developed two injectable products, AmnioFix and EpiFix, which accelerated the healing process and decreased the growth of scar tissue. MiMedx stated these products would qualify as 361 HCT/Ps under Federal Drug Administration (“FDA”) regulations. 361 HCT/Ps are exempt from FDA regulation of drugs, devices, or biological products. For a cell or tissue based product to be a 361 HCT/P, the product can only be “minimally manipulated.” According to FDA regulations, if processing alters a tissue’s original characteristics, then the product is more than “minimally manipulated.”

On September 3, 2013, the FDA sent MiMedx an “Untitled Letter” asserting that AmnioFix and EpiFix did not meet the requirements for 361 HCT/P exemptions. MiMedx publicized the letter, which resulted in MiMedx stock falling from $6.06 per share to $3.85 per share.

On September 13, 2013, plaintiffs filed suit, and their amended complaint brought claims against MiMedx and its executives under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as well as under Rule 10b-5. Plaintiffs contend that MiMedx did not inform investors that AmnioFix and EpiFix could not qualify for 361HCT/P status, because MiMedx pulverizes or grinds amniotic tissues and cells when creating the products. Moreover, MiMedx did not disclose the FDA inspected MiMedx in 2012 to examine whether the injectable products qualified as 361 HCT/Ps. The plaintiffs sought to represent a class of all purchasers of MiMedx common stock from March 29, 2012 to September 4, 2013.

In December 2013, MiMedx announced it would seek FDA approval for AmnioFix and EpiFix as regulated biologics instead of 361 HCT/Ps. On December 4, 2013, MiMedx stock price rebounded to $6.76 per share.

Claims under Section 10(b) of the Exchange Act and Rule 10b-5 require proof of six elements:  (1) a material misrepresentation or omission, (2) inference made with scienter, (3) a connection with the purchase or sale of a security, (4) reliance on the misstatement or omission, (5) economic loss, and (6) a causal connection between the material misrepresentation or omission and the loss.  In addition, a private right of action alleging fraud under federal securities law must satisfy the heightened pleading standards of both F.R.C.P. 9(b) and the PSLRA. F.R.C.P. 9(b) requires a plaintiff to set forth precisely what statements or omissions were made in what documents or oral representations, who made the statements, the time and place of the statements, the content of the statements and manner in which they misled the plaintiff, and what benefit the defendant gained as a consequence of the fraud. The PLSRA requires a plaintiff to allege facts that demonstrate a “strong inference” of scienter. 

MiMedx moved to dismiss the amended complaint arguing the plaintiffs failed to identify a culpable misrepresentation or omission of material fact, failed to plead economic loss and loss causation, and failed to properly allege a strong inference of scienter. Furthermore, MiMedx argued the court must dismiss the plaintiffs’ claim under §20(a), because the plaintiffs’ securities fraud claims failed.  

First, the court considered whether the amended complaint identified misleading statements. MiMedx published boilerplate disclaimers that the FDA may not agree with MiMedx’s classification, but the FDA regulatory process was “evolving.” The court concluded MiMedx statements misled investors to believe MiMedx entered into formal discussions with the FDA.

Second, the court addressed whether the plaintiffs’ amended complaint adequately established loss causation and economic loss when it alleged MiMedx shares declined in value following the release of the September 3, 2013 letter from the FDA. The PSLRA’s “bounce-back” provision specifies damages shall not exceed the difference between the price the plaintiff paid for the stock and the mean trading price of that security during the 90-day period beginning on the date of disclosure. Thus, the computation of damages under the PSLRA allows defendants to mitigate damages when share prices have recovered, but it does not disqualify investors from recovering altogether, when the share prices rebound.

While MiMedx’s stock price rebounded to pre-disclosure levels by the end of November 2013, the court could not conclude that the plaintiffs suffered no economic loss from the alleged misrepresentations and omissions. Additionally, AmnioFix and EpiFix accounted for only 15 percent of MiMedx’s business, which suggested to the court other factors might account for the price rebound. Accordingly, the court did not grant the defendants' motion to dismiss on these grounds. 

Lastly, the court analyzed whether the plaintiffs alleged particular facts supporting an inference of scienter. To adequately plead facts demonstrating scienter, a plaintiff must establish a defendant acted with the intent to defraud or severe recklessness in allowing fraudulent activity. In addition, to support a strong inference of scienter, a plaintiff must demonstrate that a reasonable person would be more likely to infer that the defendant acted with scienter than to infer otherwise. The complaint alleged management never sought to have the products classified as 361 HCT/Ps, and management was aware the FDA was investigating the products. Additionally, the allegations in the complaint supported an inference that the defendants knew, or should have known, the FDA would never approve AmnioFix and EpiFix for the Section 361 exemption because products developed from amniotic fluid are generally not 361 HCT/Ps. Lastly, MiMedx’s COO, William C. Taylor, sold a substantial amount of MiMedx shares following the FDA’s establishment inspection report, suggesting that Taylor knew MiMedx hid the status of AmnioFix and EpiFix from the market until then.

Accepting the allegations as true, the court concluded that a reasonable person would conclude that the defendants more likely than not acted with scienter. Ultimately, the court held the amended complaint stated a claim for relief under the PSLRA and Section 20(a). 

In conclusion, the District Court denied the defendants' Motion to Dismiss for Failure to State a Claim. 

The primary materials for this case may be found on the DU Corporate Governance website. 


UBS Subsidiary to pay over $14.4 million for violations relating to the operation of its alternative trading system. 

On January 15, 2015, the SEC issued a cease-and-desist order pursuant to Section 8A of the Securities Act of 1933 and Sections 15(b) and 21C of the Securities Exchange Act of 1934 against UBS Securities, LLC (“UBS”) claiming numerous violations stemming from UBS’s operation and marketing of its dark pool, alternative trading system. UBS agreed to settle the matter without either admitting or denying the SEC’s findings. The SEC’s order can be accessed here.  

According to the allegations in the order, UBS operated between May 2008 and August 2012, one of the nation’s largest alternative trading systems (“UBS ATS”) geared to accept, match, and execute securities transactions on behalf of UBS clients and UBS ATS subscribers. During this time, UBS violated several securities laws in the operation of UBS ATS by failing to comply with mandatory disclosure requirements and restrictions on sub-penny order transactions. Specifically, the SEC found UBS ATS violated (1) Rule 612 of Regulation NMS by generating and executing preferential sub-penny orders and (2) Rule 301 of Regulation ATS by failing to fully disclose the nature of its “natural-only crossing” restrictions and its UBS ATS access standards.

Rule 612 of Regulation NMS is intended to prevent the preferential execution of trades placed in increments smaller than one cent ahead of those placed in legal increments exceeding $0.01.  Rule 612 specifies that “[n]o alternative trading system . . . shall display, rank, or accept from any person a bid or offer, an order, or any indication of interest in any NMS stock priced in an increment smaller than $0.01.” Between May 2008 and March 2011, according to the SEC, UBS willfully violated Rule 612 by internally authorizing the generation of PrimaryPegPlus Orders (“PPP”) and Whole Penny Offset Orders through UBS ATS. UBS’s PPP and Whole Penny Offset order types were almost always illegally priced in sub-penny increments even though UBS certified that its UBS ATS order types were in compliance with Regulation NMS. Consequently, UBS violated Rule 612 by allowing its favored high-frequency-trade subscribers to get priority in execution by placing orders that were slightly better than the national best bid and best offer.

UBS also, according to the SEC, violated several subsections of Rule 301(b) of Regulation ATS by failing to establish and fully disclose the internal operating standards and procedures used to govern the execution of trades through UBS ATS. Regulation ATS mandates that an ATS comply with the fair access requirements of Rule 301(b)(5) when an ATS processes at least five percent of the average daily volume for any covered security during four of the preceding six months (“fair access threshold”). The subsections of Rule 305(b)(5) require that an ATS (1) establish and disclose written access standards for ATS trading; (2) refrain from unreasonably limiting or discriminating against any person in permitting access to its ATS system; and (3) report all client and subscriber access grants, denials, and limitations on its Form ATS-R. During June 2011 and between August 2011 and November 2011, UBS ATS failed to meet the Rule 301(b)(5) fair access requirements on as many as four covered securities that triggered the “fair access threshold.” 

Furthermore, the SEC found that because UBS failed to disclose all of UBS ATS’s access grants, denials, and limitations in its Form ATS filing, UBS willfully violated Section 17(a)(2) of the 1934 Act by “directly or indirectly, in the offer or sale of securities, obtaining money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made . . . not misleading.”

In light of the above findings, the SEC accepted UBS’s proposed settlement to pay a $12 million civil penalty, $2,240,702 in disgorgement, and $235,686 in pre-judgment interest. To date, the $14.4 million penalty was the largest penalty assessed against an ATS.  


Darden Shareholders Elect All Twelve Starboard-Nominated Directors to Board

On October 10, 2014, Darden Restaurants, Inc. (NYSE: DRI) released a statement announcing that shareholders had elected all twelve of the directors nominated by activist shareholder, Starboard Value, L.P., to replace its current board of directors. The announcement, based on the preliminary results of Darden’s Annual Meeting, signaled the end of an enduring proxy fight between the current board and Starboard. The voting results can be found here.  

Starboard, Darden’s second largest shareholder holding 8.8% of the restaurant conglomerate, openly criticized the corporate strategies implemented by the current board. In December 2013, Starboard began petitioning the current board to implement various strategies it thought would help improve Darden’s overall governance, operational efficiency, and shareholder value. In May 2014, Darden announced its plan to sell the Red Lobster chain and ignored investors’ request that the company split-off its real estate assets prior to sale. Starboard had previously argued for the creation of another publicly traded company consisting of Darden’s real estate. 

Starboard responded by officially launching its campaign to overthrow Darden’s current board. After plans to sell Red Lobster were announced, Starboard nominated twelve new directors to be elected in Darden’s upcoming proxy. On September 11, 2014, Starboard released nearly 300-pages of recommendations for improving Darden’s business. The document listed Starboard’s top priorities for Darden, with the first being: “Infusing a major upgrade in the leadership at Darden.”  

Darden’s current board then attempted to prevent a complete overturn by nominating eight new candidates, four of which were also nominated by Starboard. Investor dissatisfaction with the current board, however, was so significant that all twelve of Starboard’s nominees were elected as new directors. Speaking on behalf of the newly elected board, Starboard’s Chief Executive Officer, Jeffrey Smith, emphasized the new board is enthusiastic about putting Darden on track for long-term success and maximum shareholder value.

The new directors elected include: Betsy S. Atkins, Margaret Atkins, Jean Birch, Bradley Blum, Peter Feld, James Fogarty, Cynthia Jamison, William Lenehan, Lionel Nowell III, Jeffrey Smith, Charles Sonsteby, and Alan Stillman.

Darden is the world’s largest company-owned and operated full service restaurant company. The company manages and oversees several casual dining subsidiaries which include, among others: Olive Garden, Longhorn Steakhouse, The Capital Grill, and Yard House.  


The Misguided View of Shareholder Engagement

Michael Goldhaber has an interesting piece on American Lawyer, Marty Lipton's War on Hedge Fund Activists. The article mostly uses as a template for the discussion the views of Marty Lipton and Lucian Bebchuk (with a bit of CJ Strine thrown in). Mr. Lipton was described as asserting that "activism is awful for companies and the economy over the long run."  

At the same time, however, he was represented as having recognized that, to stop activism, boards need to encourage institutional investors to vote against activists.  "Lipton will never win his war until institutional shareholders vote against activists more. He is the first to say so, and others agree."

Yet if this were the case, the appropriate strategy would be to peal off long term and other institutional investors.  This would mean a concerted effort by management to work with, and support, long term shareholders.  There is, however, little evidence that this is the common strategy at Mr. Lipton's firm.  

Take shareholder access.  This is a proposal designed to allow mostly large (those with 3% or more alone or in a group) shareholders who have held the shares for a long term(three years) to simply have the right to submit nominees (no more than 25% of the board) for inclusion the the company's proxy firm.  One would suspect that if long term investors had this authority, they might be more hesitant to support hedge funds and other investors who engage in proxy contests.  

In fact, however, the latest missive from the Firm on shareholder access (The Unintended Consequences of Proxy Access Elections) is highly critical.  As the memo describes:  

  • Proponents of proxy access frequently speak in terms of "shareholder representation" and "democracy." These buzzwords are intended to appeal to the American understanding of political fairness. However, this metaphor fundamentally misunderstands the nature of a corporate board. In the United States, a public company board is not designed to be a representative democracy in which different directors speak for particular interest groups. Widespread utilization of proxy access could produce a system in which various factions nominate their candidates and the result could be an unpredictable array of representatives all owing allegiance to their individual sponsors. Such a situation could easily produce a dysfunctional board riven by divisive deadlocks and incapable of making decisions or providing effective oversight.

In other words, institutional shareholders should support management but management should not support institutional investors.  Perhaps that explains why institutional investors are less supportive of management than Mr. Lipton would like.   





Criminal Authorities File Charges Against Defendant in SEC Insider Trading Case 

According to the U.S. Attorney’s Office in Massachusetts, Robert H. Bray (“Bray”) was arrested by the FBI in November 2014 and charged with participating in an insider trading conspiracy for his transactions in Wainwright Bank & Trust Company (“Wainwright”) stock based on information he received from J. Patrick O’Neill (“O’Neill”). 

Allegedly, O’Neill learned through his position as a senior vice president at Eastern Bank Corporation (“Eastern Bank”) of the intended acquisition of Wainwright. Bray and O’Neill golfed and socialized at the same country club. After learning from O’Neill about the pending acquisition, Bray purchased 31,000 Wainwright shares. Bray had never previously purchased Wainright securities. When Eastern Bank publicly announced the acquisition, Wainwright’s stock price increased by about ninety-four percent. In the following months, Bray sold all of his Wainright securities generating nearly $300,000 in profits.

A few months after the transactions, the Security and Exchange Commission (“SEC”) began seeking information from Eastern Bank about trades in Wainwright stock.   O’Neill quit his job at Eastern Bank and did not respond to the SEC inquiry. The SEC then subpoenaed both O’Neil and Bray to testify in the SEC’s investigation. Both men asserted their Fifth Amendment privilege against self-incrimination for all questions addressed to them.

The SEC filed civil charges against Bray and O’Neill on August 18, 2013 for violating Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5.  This pending SEC action seeks injunctions against each of the defendants from further violations of the securities law, discouragement of profits with interest, and additional civil penalties of up to three times the defendants’ gains.  The SEC press release for this case can be found here.  The civil complaint for this case may be found on the DU Corporate Governance website. 

In addition, on October 31, 2014, the United States Attorney’s Office of the District of Massachusetts charged O’Neill with the one count of conspiracy to commit securities fraud.  The FBI press release for this case can be found here.